Despite the earnings beat, the stock crashed by close to 7% in after-hours trading as investors' focus shifted to the cautious guidance issued for the second quarter. In a notable development, company executives discussed artificial intelligence technology and its potential impact on the software business several times on the first-quarter earnings call, which makes Salesforce yet another tech giant that aims to benefit from the exponential growth in AI usage.
Today, companies of every size are aggressively investing in AI on the back of the massive popularity this technology gained with the launch of ChatGPT late last year. Salesforce, as a global leader in its chosen niche, seems well positioned to benefit from the planned investments.
The focus on profitability is paying off
Many high-growth companies focus on maintaining stellar revenue growth, at times losing focus on profitability to the extent that margins deteriorate beyond repair. Salesforce, however, has avoided this pitfall by making the necessary adjustments to its business strategy to prioritize sustainable growth. A few quarters ago, CEO Marc Benioff said the company will explore avenues to expand operating margins and, by extension, profitability. The company has stayed true to this vision.
In the first quarter, which ended on April 30, Salesforce’s operating margin expanded by 1,000 basis points year over year to 27.6%, well ahead of its target. For the fiscal year, the company raised its margin target to 28% and said operating margins of around 30% can be attained by fiscal 2025.
To drive margins higher, the company plans to focus on areas where productivity can be improved. The pricing strategy will also be closely monitored to benefit from macroeconomic trends that enable the company to charge higher prices for its products and services. Salesforce is currently working with Bain & Company to identify ways to improve the overall efficiency of the organization, and, according to Chief Financial Officer Amy Weaver, the operational review has almost come to an end, setting the stage for the implementation phase in the coming months.
In addition to operating margin expectations, Salesforce raised its earnings forecast for the full year as well. The company now expects adjusted earnings per share between $7.41 to $7.43 in comparison to its guidance for adjusted earnings of $7.12 to $7.14 last March. This meaningful increase in Salesforce’s profit forecast comes on the back of optimism surrounding its operating margin profile.
The AI growth story
Salesforce is accustomed to using AI technology to improve the experience of its customers. For years, the company has been investing in AI to integrate this technology into its product suite. For instance, Salesforce Einstein, an AI-powered platform that enables users to automate tasks and analyze data, is at the forefront of the company's AI strategy. Einstein can help businesses predict sales opportunities, proactively resolve cases even before they are reported, personalize the marketing strategy for a selected customer and create smart apps for both employees and customers. Einstein is currently available through different Salesforce products such as Sales Cloud, Service Cloud and Marketing Cloud.
With many businesses now aware of the benefits associated with embracing AI-powered solutions, there is strong demand for software solutions that offer an automated, AI-integrated experience. Building on the recognition of Salesforce Einstein, the company is planning to launch Einstein GPT, the world’s first generative AI technology for customer relationship management. Customers will be able to improve their efficiency meaningfully with the help of the generative AI technology, which will generate emails, start conversations and create offers based on real-time data.
Salesforce is aggressively investing in its AI capabilities to leverage the first-mover advantage it is enjoying in the field of AI-driven CRM solutions. Although these investments could exert pressure on the company’s margin profile in the short run, it is doing the right thing by cutting costs where possible to funnel savings into AI investments.
Salesforce is not cheaply valued
Growth companies are seldom cheaply valued as investors attach premium valuation multiples for high-growth businesses in anticipation of stellar revenue and earnings growth. Salesforce, valued at a forward price-earnings ratio of 31, is not cheaply valued today. However, at a time when the company is laser-focused on profitability, long-term-oriented investors might feel comfortable investing in Salesforce as it is in much better shape to convert growing revenue into a steady stream of earnings compared to a few years ago, when the strategy was to achieve growth at any price.
Salesforce shares fell following the first-quarter earnings release. The company, however, is exceeding the original operating margin targets announced at the end of the previous year. Growth-oriented investors with an above-average risk tolerance might want to make the most of the current pullback in the stock by doubling down at seemingly fair prices.